How franchisees are fighting back

For many of Australia’s 69,000 franchisee operators, franchising is all about a delicate balance of power. For most of the last decade, as the sector enjoyed explosive growth, the franchisors held the power – and were prepared to use it.

But in the last 12 months, the franchisees have tried to take the power back.

They’ve created franchisee activists groups, such as the National Franchisee Coalition. They’ve launched media campaigns and websites to denigrate well known franchise groups such as the The Cheesecake Shop, Australia Post and Refund Home Loans. And they’ve tried to abandon a failed franchisor completely, in the case of book retailer Angus & Robertson.

And in South Australia, the franchisee crusaders have had their biggest victory yet. Not only have they managed to win the power to put in place state-based amendments to the Franchising Code, but they’ve also seen franchisee advocate Frank Zumbo appointed as the state’s new deputy small business commissioner.

Brad Skuse, a Cheesecake Shop franchisee and member of the National Franchisee Coalition, says Zumbo will “certainly make some fantastic changes if he’s allowed to”.

He says after years in franchising, and plenty of stops and starts when it comes to franchisees’ rights, there are “people behind the scenes that are working really hard to have things changed”.

Narelle Walter, another member of the National Franchisee Coalition and former franchisee, says not only are disputes on the rise, their prevalence is underestimated by non-disparagement clauses in franchising contracts. The Franchise Council of Australia does not agree that dispute numbers are increasing.

Walter says since being formed in mid-2011, the franchisee body has received hundreds of complaints ranging from end-of-contract terminations, misleading and deceptive conduct, abuse and harassment. She says the body serves as a sounding board and collects grievances to pass on to politicians as it lobbies for change.

Asked what the National Franchisee Coalition is looking for, she says federal reform – that is, the requirement for franchisors to negotiate in good faith, and penalties for breaches of the Franchising Code of Conduct.

“But we are more than happy to have it at a state-based legislation,” Walter says.

“At our end, we’re going to be working to ensure that every state is well aware and implements those recommendations.”

Reputation for disputes

As advisory firm KordaMentha puts it, the “franchising industry (perhaps unfairly) has a reputation for disputes between franchisors and franchisees and of rogue franchisors taking advantage of ‘mum and dad’ franchise operators”.

“The industry needs to clean up this tarnished image and sell the strong growth story to potential franchisees and credit providers,” it says in a report on franchising released this month.

KordaMentha isn’t the one talking about franchising’s image problem. The Australian Competition and Consumer Commission has put it another way, with chairman Rod Sims saying last year that it was “difficult to ignore” the just over 600 franchise-related complaints to it about franchising.

While more recent franchising dispute numbers are hard to measure, Greg Nathan, an ex-multi-unit franchisee and ex-franchisor executive with bread business Brumby’s, says a recently completed study of 2,000 franchisees across all industries shows that about 70% to 75% are feeling satisfied and confident, but there are major differences between franchise groups.

Nathan, founder of the Franchise Relationships Institute, estimates that about 17% of franchisees across a group are dissatisfied at any one time, but says that matches international experience – and is simply a “fact of life”. Of that 17%, he says about one-fifth are in litigation against their franchisor. Overall, he believes franchising in Australia is well run.

Stan Gordon, of Franchised Food Company, says some conflict can be traced back to a misguided view that franchising is an easy way to make money.

“I think there’s a problem in franchising where every bloke with an idea thinks he can franchise. It’s not as easy as that. And as the economy goes down and things get tougher, it will be survival of the fittest and the more mature and experienced system.”

Why the bad rap?

A report by KordaMentha, released this month, pinpoints four reasons for underperformance:

• Inherent weakness in the franchise business model.
• The specific territories in which the underperforming franchisees are located.
• The location and/or quality of the outlet within a particular territory.
• The performance/capabilities of individual franchise operators.

But Trevor Banks, who will soon finish up as a Wendy’s franchisees after a bitter public battle with the ice cream chain, nominates other problems:

• When a franchise collapses, it can take everything at wholesale prices and then resell it to another franchisee.
• Franchisors, such as private equity firms, who borrowed big before the global financial crisis and want to flip the asset.
• Non-disparagement clauses that ban franchisees from taking legitimate grievances to the media.

Bruce McFarlane, franchising expert and partner at law firm Hall & Wilcox, says there are systems in Australia that are franchisor-focused, and others are more partnership-type arrangements.

“But nobody will make statements to say franchising is unfair, because it’s been extremely successful in Australia,” he says. “If it’s such a failure, people wouldn’t still be doing it.”

“At the end of the day, some franchisees will fail because you can’t legislate against business failure. Some people aren’t very good at running businesses and some will be disgruntled because their expectations weren’t met.”

McFarlane adds there are lots of checks and balancing in franchising, including the Franchising Code of Conduct and the random audit powers of the ACCC.

The state roars

One way to look at growing activism among franchisees are recent moves that go beyond the federal Franchising Code of Conduct towards state-based laws that compel franchisors to negotiate in good faith and put financial penalties on breaches of the code.

South Australia is set for a small business commissioner this year and a similar vote in Western Australia to attach penalties for breaches of the franchising code went down by just one vote.

SA’s choice of Frank Zumbo as deputy small business commissioner also raised eyebrows among the Franchise Council of Australia, which represents both franchisees and franchisors.

“In the context of someone who is tasked with mediating disputes, he’s been an active protagonist in the debate,” Franchise Council of Australia chairman Stephen Giles says, drawing attention to Zumbo’s many criticisms of the industry and continued commentary on “rogue franchisors”.

“We don’t see rogue franchisees out there. And if there are, the ACCC should come out there like a tonne of bricks,” Giles says.

The franchising body has also warned that the state risks a business backlash; Game Traders chief executive, Mark Langford, recently stated he would not open any new stores in his home state in protest.

But Zumbo says developments in SA are only a “tiny part of the picture” for franchising, and franchising is only one part of his new remit.

He adds a small business commissioner, tasked with delivering fast and efficient dispute resolutions, is “only a positive thing”.

Franchising expert Bruce McFarlane says Zumbo’s appointment is a “massive” thing for franchising and everyone will be waiting to see what he does in the role.

“If it goes as the FCA expects, national franchisors will decrease their investment in SA. I don’t think existing franchisors will pull out, but those considering it probably will be deterred.”

But Wendys franchisee Trevor Banks describes Zumbo’s appointment as a “Godsend” for franchisees, and he’s not alone: activists argue the FCA’s anger reflects a fear the associate professor in business law at the University of New South Wales will actually improve conditions for franchisees.

Challenges in 2012

Beyond state-based changes, McFarlane says the fragile economy, attracting appropriate franchisees, and the prospect of class actions by plaintiff law firms are the biggest challenges for franchising in 2012.

McFarlane says last year’s big collapse in franchising – of the book chain Angus & Robertson, part of the private equity-owned REDgroup Retail – could well be repeated elsewhere this year, adding that tough business conditions often prompt a rise in disputes.

Worryingly, KordaMentha tips the sector will expand by just 3.3% in the five years from 2012-2017, down slightly from the 3.4% annual growth from 2007 to 2012.

And KordaMentha paints a picture of declining profitability and revenue from 2010 onwards. Over a three-year period, franchisor profits are tipped to lift by 13% per annum, with revenue at 11% over the same period, versus a bumper year in 2010 in which franchisor revenue soared by 17% and franchisor profitability grew by 22%.

Similarly, KordaMentha tips 10% revenue growth for franchisees over a three-year period, with revenue up by 9% per annum, lower than levels recorded in 2010.

But Franchise Relationships Institute founder Greg Nathan disputes the assertion that conflict will inevitably rise with difficulties in the economy.

A registered corporate psychologist, Nathan says franchising relationships break down when a franchisee loses faith in the franchisor’s ability to plan for the future, or starts to doubt the company has its best interests at heart.

And Rod Young, founder and executive director of franchising specialist firm DC Strategy, says an expected rise in bankruptcies through the year will deliver opportunities for survivors to mop up market share – and attract quality recruits.

“A lot of it is to do with how franchise owners think and behave during difficult times,” Young says.

Where’s the growth?

Young says the aged care sector, childcare and home services will likely enter a purple patch, and there are home handyman franchises and restaurants doing very well as the number of single people, smaller households and shared households increase.

Greg Nathan adds that with Australians working longer hours, and increasingly outside of traditional work hours, franchisees offering “lifestyle-friendly” businesses will attract interest. “Retail is a seven day a week job, so if you’re not well-organised it’s difficult to take time off and you can get burnt out,” he says.

Consolidation is likely to emerge as another theme in 2012, with KordaMentha saying that bigger is often better in franchising.

“Larger franchisors are taking advantage of an increasing number of smaller players who are struggling to maintain profitability by engaging in consolidation activity.”

“Australian franchising is expected to experience a consolidation path similar to that of the US franchising industry five years ago.”

Interestingly, even as franchisees push to level the playing field, there are expectations that franchisors will increase their power through multi-unit franchising.

McFarlane expects franchisors to be more proactive in helping potential franchisees with funding, especially for multi-unit systems. Nathan concurs that multi-unit and multi-branded franchising is “going to grow big time”.

“In the US, it’s a massive trend, but Australia has been slow to take up multi-unit franchising,” McFarlane says. This is often because the franchisor is reluctant to deliver greater leverage to a franchisee, or wants to avoid looking after multiple stores if the franchisee goes bust.

Another path franchisors go down to boost growth is setting up company stores to sell down the track to franchisees down the track, McFarlane says, as juice chain Boost has done with its new Mexican food business Salsa.

Interdependency

The Franchise Council’s Stephen Giles says that although you can be “blinded by regulatory reforms and very vocal ex-franchisees,” the FCA is actually not seeing a lot of disputes.

“There might be a lot of franchisee activism, but it’s been driven by a vocal minority. I’ve seen other major disputes where the franchisors have sorted it out and both parties are happy.”

Giles says that although franchising’s survival capability is second to none, the FCA would like to see an increase in franchise profitability, which has been curbed by higher costs, competition, falling turnover at shopping centres and penalty rates.

The new deputy small business commissioner in SA, Frank Zumbo, says there are plenty of other challenges beyond franchisee activism for franchising to look at: access to finance, high rents, difficulties in recruitment, poor business confidence and weak confidence in the model.

“As economic conditions become tough, franchisors may become tough and franchisees may become tougher,” Zumbo says.

Given the “danger of friction” in these patchy economic times, he says building confidence in the model should be a priority for the industry.

“Potential franchisees will see challenges in franchising, quite apart from economic ones.”

Greg Nathan says stemming conflicts across Australia’s 1,000-odd franchise systems lies not in state-based legislation but continued education:

• Sharing information.
• Improving accountability.
• Reminding franchisors of the commercial case that satisfied franchisees help the company grow.

According to Nathan, franchisees are most satisfied when they:

• Believe the franchisor has the competence and strategic vision to lead.
• Believe the franchisor genuinely cares about their success.
• Believes the company operates with integrity.

“What breeds trust is transparency,” Nathan says.

As KordaMentha puts it: “While much attention has been paid to the impact on franchisees when franchisor businesses fail, franchisors are also exposed to the failure of their franchisee.”

This in mind, perhaps that negative reputation might be something else to change in 2012.